It's Time to Rebuild on Savings, Not Borrowing

When it comes to your personal balance sheet, there's good news and bad news — according to economists. The good news is that you're saving more; the bad news is that you're spending less. That should teach you never to run your personal finances based on economists' advice.

Seriously, it's pretty good news on an individual basis that we Americans have stopped our spending binge and started saving. Just to put the statistics in perspective, Americans have historically saved about 4 percent of their disposable income. That all changed after the turn of the century.

The savings rate plunged below zero in June 2005. Americans were actually dis-saving — financing their lifestyles on credit cards and home-equity loans. When the economy slowed, that huge debt bubble burst, leaving millions on the brink of disaster.

The good news from last week's Federal Reserve report on household debt is that the total consumer debt, including mortgages and credit-card balances, fell 1.7 percent in 2009 — to only $13.5 trillion. It was the first annual drop since they began keeping records in 1945.

The bad news is the way much of the decline occurred. Sure, some people got smart, or worried, and paid down their credit-card balances. But many more went bankrupt or defaulted on mortgages. When a lender takes a "write-off," that amount simply disappears from the consumer borrowing statistics.

In other words, a lot of our personal debt simply disappeared down a black hole.

Sure, your loan default shows up to lower your credit score, but it also allows many people to get that well-advertised "fresh start" — without the burden of debt repayment. If you're wondering why you shouldn't take advantage of this process, you're like the woman I wrote about recently — wondering why she's struggling to pay her debts while others simply start over.

Since those who default will eventually get new credit as the politicians strive to get the economy moving again, this has become more a moral question than an economic one.

Even more disturbing is the current cheering from economists who look at the Fed's household debt statistics. They think the lower debt figures are encouraging — and not just because it shows people trying to live within their means.

Many economists say the drop in the debt level prepares consumers to start buying again. Since the American consumer accounts for about two-thirds of our domestic economy, and about 20 percent of global economic activity, this opportunity is seen as beneficial by economists.

This is where you come in. I've been "preaching" for years that it's not your "patriotic duty" to spend the economy into prosperity, while you take on debt. I've always advised paying down your mortgage so that your home would be debt-free by retirement.

Now, assuming you still have your job and your home, you have the chance to start the next up-cycle on sound, debt-free or lower-debt, footing. You'll want to keep investing in future growth for your retirement. But this time around, you'll consider twice before spending instead of saving and investing.

I can read your mind. "What if everyone took this attitude and stopped spending," you're wondering. The answer is simple. Human nature being what it is, relatively few will learn the lesson of this economic decline. When the economy starts growing again, they'll start shopping. Financial institutions, eager to make money on loans, will lend again — even to those who defaulted in the past.

But next time around, the debtors won't get off so easy. First, they'll be competing with the huge borrowing needs of the federal government. Second, lenders will be smart enough to protect themselves with variable-rate loans on credit cards and mortgages.

Then the combined borrowing demand will quickly push interest rates higher — either in competition for funds or in fear that the Fed will print money and cause inflation. Those punishing high rates will stop the next boom in its tracks relatively quickly.

If you're a consumer who understands that the next down-cycle will be even more devastating, you'll take advantage of the current pause to lock in a fixed mortgage rate. If you can, you'll even pay extra on your mortgage loan. You'll avoid rolling credit-card debt past the end of the month. You'll be one of the smart ones who rebuilds a life on savings instead of borrowing.

These personal decisions are all part of a global economic cycle that is becoming more volatile, more amplified and more punishing. You've been given your chance to get off the roller coaster and stand on firm ground. Use that chance wisely, and you'll be glad you did. That's the Savage Truth.